Flashback to fall 2008 and you’ll remember the free fall the US economy experienced. At the heart of it was the collapse of the housing market.
If you were house hunting before the crash, you could choose between an array of loan products to keep your payments low such as an interest-only loan, a ‘‘choose-your-own-payment’’ loan, a balloon payment loan, or an adjustable-rate mortgage (ARM) with an extremely high cap. If your credit score was low, you didn’t have money for a down payment, or your income was erratic, you could get around all those obstacles with a no-documentation loan, sometimes for as much as 125 percent of the home value.
Now that a decade has passed, industry insiders look back at where we were, what we learned, and where we go from here to ensure that the trauma of the housing boom-and-bust and the Great Recession are not repeated.
Today’s home buyers are in different world:
Despite the homeowners’ loss of $16 trillion in net worth and the 10 million people who lost their homes to foreclosure during the crash, one reality — though diminished — hasn’t changed: The majority of Americans want to own a home.
‘‘There’s a remarkably high preference for homeownership that shows up in every survey of renters,’’ said Chris Herbert, managing director of the Joint Center for Housing Studies of Harvard University. ‘‘Ninety percent or so of renters still want to become homeowners. Certainly, young people are moving into homeownership more slowly, but that’s because of a host of reasons such as marrying and having children later, a reduced ability to save since the recession, and that it’s harder to get a loan. It’s not because of a fundamental change in attitude.’’
The housing market has generally recovered. Prices across the United States, which fell 33 percent during the recession, have rebounded and are now up more than 50 percent since hitting the bottom, according to CoreLogic, a global property analytics site. Still, some markets in Arizona, Florida, Illinois, and Nevada have yet to reach their pre-recession levels.
Homeownership rates peaked at 69.2 percent in 2004 and dipped to 62.9 percent in the second quarter of 2016, according to the Census Bureau. Rates have slowly climbed over the past two years to 64.3 percent in the second quarter of 2018.
‘‘Clearly, there hasn’t been a rush to homeownership back to the rate it was during the housing boom,’’ said Rick Sharga, executive vice president of Carrington Mortgage Holdings in Aliso Viejo, Calif.
Lingering nerves from the housing crisis continue to affect home buyers, lenders, builders, and other industry professionals.
‘‘Even if you weren’t part of the home-buying bubble, you were part of the economic fallout or you knew someone who lost their home to a foreclosure or short sale,’’ says Elizabeth Mendenhall, president of the National Association of Realtors and a realtor with RE/Max Boone Realty in Columbia, Mo. ‘‘As a result, people are having deeper discussions before they buy to make sure they don’t end up losing their home.’’
Real estate agents are less likely to push buyers toward the most expensive house they can qualify for, Sharga said.
‘‘Hopefully consumers and realtors know the difference between the ability to qualify for a home and the ability to maintain and truly afford it now,’’ Sharga said.
In addition to people who lost their homes, lenders and builders experienced tremendous financial pain, Herbert said.
‘‘That pain has left them more risk averse, so lenders are more cautious when providing financing to consumers and to builders,’’ Herbert said. ‘‘At the same time, we’re seeing housing starts lower than they should be, which is a sign of risk aversion among builders.’’
The crisis is still in the forefront of the minds of everyone in the lending industry and influences their decisions, said Michael Fratantoni, chief economist of the Mortgage Bankers Association in Washington.
‘‘Many of the products that started the crisis aren’t around, and the practices that started it are severely constrained,’’ Fratantoni said.
Among those homeowners who lost their home to a short sale or foreclosure, about 35 percent have now purchased another home, according to CoreLogic.
‘‘That means that 65 percent didn’t come back,’’ says Frank Nothaft, chief economist at CoreLogic in Washington. ‘‘We don’t fully know why those people have yet to buy again or what kind of long-lasting impact that will have.’’
Lenders and policymakers learned the hard way that easy credit and the erosion of underwriting standards are not the solution to higher demand for loans, Nothaft said.
‘‘Low documentation and interest-only loans were OK as a small niche for otherwise qualified borrowers with specific circumstances,’’ he said. ‘‘The problem was that these risky loans became widely available to subprime borrowers.’’
About one-third of all mortgages in 2006 were low or no-documentation loans or subprime loans, Nothaft said. ‘‘Now people understand that loans must be sustainable, otherwise everyone loses. A foreclosure hurts families, communities, lenders, and investors.’’
While regulations such as Dodd-Frank changed the financial world, lenders and investors also lost their appetite for risk and have changed their behavior, said Sam Khater, chief economist of Freddie Mac in McLean, Va. As a result, Khater said, mortgage performance is better than it has been in 20 years.
Appraisers shared some of the blame for overinflated home values during the housing boom, in part because lenders were able to directly communicate with appraisers their expectations for a home valuation to match escalating prices.
‘‘Regulations are in place now to put a firewall between the appraisal process and the underwriting process,’’ said James Murrett, president of the Appraisal Institute and an executive managing director of Colliers International Valuation Corp. in Hamburg, N.Y.
A lingering impact of the financial crisis is that private mortgage lending remains limited.
‘‘That’s partly because investors don’t have faith in the system,’’ Herbert said, ‘‘so some borrowers who don’t fit in the normal box may still not be able to get credit.’’
Essentially, he said, lending to people with credit scores below 620 is virtually nonexistent now.
At the peak of the housing boom, borrowers with a credit score of 620 to 640 qualified for the lowest interest rates on conventional loans. Credit scores for FHA borrowers were in the mid-500s. By contrast, in July 2018, according to Ellie Mae, a mortgage analytics company, 70 percent of borrowers had a FICO score more than 700. The average FICO score for conventional loans for a home purchase in July 2018 was 751, more than 100 points higher than what was considered worthy of the best mortgage rates from 2004 to 2006.
One reason for those higher average credit scores, Khater said, is that many borrowers with lower credit scores don’t apply at all for loans.
‘‘The share of mortgage applicants with FICO scores below 640 used to be around 25 percent, and now it’s just three or four percent,’’ Khater said.
Applicants with credit risks dropped out of the market in response to significantly tighter credit standards by lenders after the foreclosure crisis, when even those with good credit were sometimes denied loans.
‘‘A study by the Urban Institute found that between 2009 and 2016, there were 6.3 million people with FICO scores between 660 and 710 who normally would have qualified for a mortgage before the crisis who couldn’t get a loan,’’ Sharga said. ‘‘The irony is, they might have qualified based on the guidelines from Fannie Mae and Freddie Mac and FHA, but the lenders themselves were reluctant to take on any risk.’’
One reason that lenders continue to be risk-averse, even as credit appears to be more available in recent years, is that regulations for lender errors and misjudgment are punitive and, at the same time, it is much more difficult to complete a foreclosure, Sharga said.
‘‘It was an overcorrection to have foreclosures routinely take 1,000 days,’’ he said. ‘‘While some consumer protection makes sense, extending foreclosure almost indefinitely just delays the inevitable.’
While some industry observers worry that subprime or ‘‘nonprime’’ lenders are making a comeback, Herbert said he sees little indication that the volume of lending to people with very low credit scores is increasing.
‘‘The combination of rising home prices and rising mortgage rates is creating affordability issues, which has led some people to be concerned about whether lenders will loosen credit to ease mortgage lending,’’ said Fratantoni. ‘‘But regulations have put up guardrails against too easy credit and, at the same time, there’s a change in behavior among lenders and consumers.’’
Some areas of lending are easing, such as the increasing availability of low down payment loan products and higher allowable debt-to-income ratios, which compare your monthly recurring debt payments with your gross monthly income. However, Khater said lenders no longer layer multiple risk factors as they did during the housing boom, such as allowing borrowers to take out interest-only loans without documenting their income or their debts.
‘‘One reason some borrowers qualify with a higher debt-to-income ratio today is that renters in some high-cost markets are paying 40 to 50 percent of their income on rent,’’ Fratantoni said. ‘‘If they’re showing us they can handle that larger housing payment as a renter, then they should be able to handle it as a homeowner, too.’’
Loan approvals are always a balancing act, he said, because the goal is to serve borrowers and yet make sure their purchase is sustainable.
‘‘At Carrington we have loan products for people with less-than-perfect credit, but if they have risk in one area, such as a lower FICO score, we use common sense underwriting to make sure it’s offset in other areas,’’ Sharga said. ‘‘We follow the ability-to-repay rule and manually underwrite every loan in every file to make sure we know they can repay the loan.’’
Sharga says borrowers are walked through the entire process so they know what they are signing. In addition, he points out, there are no loans that require a balloon payment. Adjustable-rate borrowers must be qualified on the highest possible payment, not the initial payment.
‘‘There’s not a great hunger among investors to buy badly underwritten loans,’’ Sharga said, ‘‘but there is an appetite for non-QM [Qualified Mortgages as established by the Consumer Financial Protection Bureau] that are fully documented and fully underwritten.’’
Rapid price appreciation occurred during the housing boom despite the availability of inventory, Fratantoni said, unlike today, when price increases are a result of limited supply and increased demand.
‘‘People were buying second and third homes to flip in the rush to take advantage of the housing boom,’’ he said. ‘‘Then, people would just take on more mortgage debt to buy. Now, consumers are more likely to wait until they have the money to sustain homeownership.’’
Rising demand among millennials, full employment, and the strong economy have bumped against limited inventory, Nothaft said, which fuels price increases. A potential recession in 2020 or 2021 could slow sales and price growth, he said, and possibly cause prices to flatten or even dip in some of the high-priced markets that have seen intense growth in recent years such as Seattle and coastal California cities.
‘‘From the low point in home prices six years ago, home prices have increased 48 percent while wages have increased by just 14 percent,’’ said Mendenhall, president of the National Association of Realtors.
The aftermath of the recession, including the sharp drop in mortgage rates, contributes to the lack of available homes for sale.
‘‘Homeowners have very low interest rates so they’re less likely to want to move and take out a new loan,’’ Mendenhall said. ‘‘Some people also had financial issues due to the recession, and, depending on the market, home prices haven’t escalated enough so they’re still underwater.’’
An estimated 5.2 million households with a mortgage still owe at least 25 percent more than the value of their property, according to ATTOM Data Solutions, which is about 9.5 percent of households with a mortgage.
‘‘A lack of mobility is holding back the housing ladder,’’ Khater said. ‘‘People used to stay in their homes about five years, and now it’s about 10 years. Seniors are holding onto their homes longer in part because they’re working longer and because they have very low interest rates. In addition, they don’t often like what’s available to buy. GenXers bought their homes at the peak of the market, so they’re still waiting to build more equity.’’
New construction lags in part because of the reduced appetite for risk among builders and among lenders who provide financing for smaller builders, Herbert said.
Other factors that limit construction, said Rob Dietz, chief economist of the National Association of Home Builders (NAHB), include the shortage of construction labor and rising costs.
‘‘According to the Bureau of Labor Statistics, there are currently 263,000 unfilled construction jobs,’’ Dietz said. ‘‘Land prices have risen and so have lumber costs, along with higher impact fees since the recession. NAHB estimates the regulatory costs are 24 percent of the price of a single-family home.’’
Post-recession tightened credit hurt builders as well as consumers. While big publicly traded builders have other resources, Dietz said, three-fourths of single-family home builders get most of their financing from community banks, which continue to have tight credit policies.
‘‘We have been underbuilding for years,’’ Dietz said. ‘‘We expect to start about 900,000 single-family homes in 2018, when the market could absorb about 1.2 million houses.’’
Another constraint on construction of single-family houses, particularly in markets with strong job growth, are zoning laws and land-use rules, says Dietz.
‘‘Markets can’t respond to job and income growth with more housing because of construction and density restrictions, which creates economic inefficiency,’’ he says. ‘‘This reduces mobility and will have a generational impact. That’s why we see strong housing growth in places like Idaho and Utah and Montana and Colorado, along with Texas and much of the Southeast, because those places have less regulatory constraints. It’s more affordable to build in those places compared to coastal cities that restrict density.’’
Among the lasting fundamental changes brought about by housing crisis, says Sharga, is that people today look at a home as place to live, not as an investment.
‘‘It’s important to realize that homeownership is something to aspire to, but it’s also important to be ready for it,’’ he says. ‘‘It can be a wealth builder, but, as we saw, it can also be the quickest path to financial devastation if you’re not prepared.’’